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July 31, 2004

The Next No.1 Crossing Network?

By Peter Chapman

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  • The Next No.1 Crossing Network?

An ATS loses ground to an upstart

Liquidnet is making a run at becoming the largest electronic crossing network.

The block trading system is closing in on archrival POSIT as the largest crossing network for the buyside. At the same time, it is steadily moving up the ranks of institutional brokerages.

"We've reached critical mass," says Seth Merrin, Liquidnet's founder and chief executive. "People are feeling the pain of not being in the system."

For the quarter ended June 30, Liquidnet averaged 19.8 million shares per day. That's more than double its volume of a year ago. The surge puts the upstart within spitting distance of POSIT, a service of brokerage Investment Technology Group. POSIT, said to be losing business to Liquidnet, traded an average of 22 million shares per day in the second quarter.

The growth at Liquidnet has outpaced that of the overall market in each of the past five quarters. In this year's second quarter, in fact, Liquidnet's share volume jumped 16 percent from the first quarter. That's while trading in the broader market fell.

Liquidnet's growth is making it a bigger threat to the block desks of the major brokers. In the fourth quarter of last year, the broker dealer ranked 15th in a survey as measured by the dollar value of all trades in listed securities by institutional brokerages. The survey, conducted by the Plexus Group, a unit of J.P. Morgan Chase, placed Liquidnet 20th in Nasdaq trading. About 60 percent of the shares traded by Liquidnet are listed; the balance are Nasdaq.

The survey is relevant because Liquidnet, legally an alternative trading system, positions itself as an institutional brokerage. It does not consider itself an exchange-like utility, in contrast to most ATSs.

Although Liquidnet describes itself as a community' and its users as members,' it does not permit brokers to join. Liquidnet is only open to buyside accounts. Liquidnet sees itself merely as a block desk, without the human traders. That's even though it has operational staff.

At least one bulge-bracket shop has come out with a similar anonymous trading model. Banc of America Securities launched its service this spring. Customers submit the name and quantity of the security they wish to trade. BofA then responds with a two-sided quote. If the buyside trader likes the pricing, he clicks and the trade is done.

With two key exceptions, BofA's system works pretty much like Liquidnet's. A buyside trader is notified of a potential contra to an order sitting on his order management system in the Liquidnet system. If he wants to trade, he goes active.' If the contra also wants to trade, he submits a quote. The two parties then negotiate anonymously via text chat.

The differences between the two methodologies, however, are significant. First, BofA is committing capital, thus the price will likely fall outside the spread. With Liquidnet, most trades occur within the spread, many at the mid-point. In other words, the pricing on Liquidnet is better.